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How the Tax Code Discourages Investment, in One Statistic

If you’re a business owner or self-employed, you’ve probably noticed that the U.S. tax code has different rules for investments than it does for most other business expenses.

Usually, when a business spends money on an “ordinary and necessary” expense – like office rent, heating costs, and postage stamps – it is able to deduct the cost in the same tax year. However, when a business spends money on investments – such as machinery, buildings, or even farm animals – it is usually required to deduct the cost over many years.

There’s good reason to believe that requiring businesses to deduct the cost of their investments over long time periods discourages them from making investments. This is because businesses generally prefer to receive money in the present, rather than the future. A deduction received five years into the future is worth less than one that can be taken today.

As a result, the U.S. tax code gives businesses a good reason not to make investments: they’ll get a bigger deduction from spending their money on other things.

Is there any way to measure how much the tax code discourages businesses from making investments? Today, the Tax Foundation released a study titled Cost Recovery for New Corporate Investments in 2012 that tries to do just that. Using data from the IRS about new investments made in 2012, the paper estimates a single statistic: how much U.S. corporations value the deductions they receive for their investments over time, compared to the cost of the investments.

The results are disheartening: over time, U.S. corporations will only be able to deduct 87.14 percent of the cost of investments they made in 2012, in present value terms.

To illustrate why these results matter, imagine a construction company that is deciding whether to spend $100 on a new investment or on postage stamps. If the company decides to buy the postage stamps, it will be able to deduct $100 immediately. But if the company spends its money on a new investment, it will only be able to deduct $87.14 over time, on average. All else being equal, the company will choose to purchase the postage stamps – a clear example of how the U.S. tax code discourages investments.

Ideally, the U.S. tax code would put investments on an equal playing field with other business expenses; businesses should be able to deduct 100% of the cost of their investments, not 87.14%. Given that saving and investment are in a long-term decline, improving the treatment of investment in the tax code should be a major policy goal of Congress.

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The Tax Policy Blog is the official blog of the Tax Foundation, a non-partisan, non-profit research organization that has monitored tax policy at the federal, state and local levels since 1937. Our economists welcome your feedback. If you would like to send an e-mail to the author of a blog post, please click on that person's name to locate his or her e-mail address or visit our staff page here.

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